The Power of Basis

Greg Mockenhaupt ProEdge Risk Management Consultant 

Greg Mockenhaupt
ProEdge Risk Management Consultant

Grain markets have been very exciting since early March. Well, I guess I should say soybeans have been very exciting, with July beans seeing $2.295 rally since March 2nd! That’s easy to get excited about until you called for a cash bid and found the cash price to be only up slightly from the previous bid. Why is this? I want to talk specifically about processors. Understanding that processors are the final stop for your grain, it stands to reason why they “set the market.” 

The function of basis is to act as the knob on a faucet.  The market goes up; grain starts to move, and the processor needs to slow down the flow.  So what do they do? Turn down the faucet (IE Basis). On the contrary, if farmers are not moving enough grain to keep the processor at production levels they are forced to pay more and turn up the faucet.  

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Another consideration is a simple function of business. If the market rallies $1.00, the processor will consider it good business to keep a percentage of the rally as profit. For example 5/10/16 the USDA report was released, and the market rallied. Cash bean prices shot up and processors quickly adjusted basis downward. This is a consideration when marketing. The chart below gives actual basis numbers and how they responded to the futures market. Look specifically at USDA report day 5/10/16. 

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Cash Price = Futures + Basis 

There are two risk factors to consider when pricing your grain. Futures and basis both are factors. Since these are usually inversely related, basis is often best locked in when market prices are down and vice versa.